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Saturday, March 10, 2007

Carbon offsets

Brookings’s Gregg Easterbrook has an interesting op-ed in the NYT yesterday about so-called carbon offsets. In keeping with my promise to Dan Markel to write at least some stuff about economics and policy, I mention Easterbrook’s column for two reasons. First, it’s generally quite good. Second, there’s one key economic point that he either misses or just de-emphasizes--namely, Easterbrook basically ignores what economists call the external nature of carbon emissions’ costs. This point is one that anyone who thinks about policy (and lots of law-&-econ-related policies in situations where transactions costs prevent us from seriously relying on the Coase Theorem) should understand. According to TerraPass (the offsets company that Easterbrook discusses), they work like this:

When you buy a TerraPass, your money funds renewable energy projects such as wind farms. These projects result in verified reductions in greenhouse gas pollution. And these reductions counterbalance your own emissions.

What you do is figure out the size of your "carbon footprint"--say, based on the type of car and number of miles you drive, or maybe your house’s electricity bill--and then pay TerraPass an amount sufficient to allow the company to do stuff that reduces total carbon emissions by the appropriate amount.

For example, Easterbrook has used former Vice President Al Gore’s utility bill to determine that "TerraPass charges $1,247.50 for one year of carbon offsets for a home like Mr. Gore’s." Why Gore? Easterbrook explains:

LAST month, to the delight of many global-warming skeptics, it was revealed that Al Gore uses 20 times as much electricity and natural gas at his Tennessee house than the national average. Out of curiosity, I put the former vice president’s power bills and ZIP code through the home-emissions calculator of TerraPass….

TerraPass estimated that the power use of a house equivalent to Mr. Gore’s causes 377,000 pounds of greenhouse gases annually. That is roughly the annual carbon emission of 20 Hummers. Next time you see Mr. Gore wagging his finger about the energy sins of others, picture a caravan of 20 Hummers driving to the Academy Awards.

A Gore spokeswoman told the press that the former vice president pays extra for wind energy, and buys carbon offsets.

My purpose here isn’t to comment on Gore in particular, or for that matter his critics. Rather, as I note above, I want to focus on an important economic point regarding external costs.

Here’s Easterbrook’s characterization of the logic of offsets: This all seems a classic example of economies of scale. Individuals can’t do anything about landfill methane. But a company like TerraPass can combine the resources of many to accomplish this task, allowing the person of good intent to use energy with no net contribution to the greenhouse effect. Whether companies marketing offsets really do reduce greenhouse gases is something for consumer reporters or the Federal Trade Commission to determine. Assuming the sellers do as promised, buying carbon offsets isn’t an exercise in guilt. It’s smart economics. Is Easterbrook right? Well, sort of, and not really. Both, at the same time. He’s got a point about economies of scale--it’s difficult to imagine running your own personal wind farm (at least, with current technology).

So where does he go wrong? It’s definitional that the incentive problem spawning negative externalities--and climate change-inducing carbon emissions are a great example--arises because people do not bear all the costs of their own actions. (If they did, we economists would say that they had fully "internalized" these costs--the logical complement to "internal" being "external", you can see why we use the term "externality").

So, the reason why we get too much carbon emission is that when I drive my car, I bear only a small fraction of the environmental costs (current and future) that I inflict on the world. And the same for you, and you, and you and you and you. Yet I get all the benefits of driving my car (getting from A to B, primarily). Now, optimizing agents--Homo Economicus, if you will--necessarily choose activity levels so as to equalize the marginal benefits and marginal costs each person will drive too much, use too much electricity, and so on (unless, of course, public policies are implemented to cure this problem).

Perhaps an example will be helpful. Suppose that each additional pound of carbon emissions reduces economic welfare of each person in the world by P dollars (never mind how we figure out what P is--that’s a discussion for another time). So the cost to Jonah B. Gelbach of emitting one more pound of pollution is P, since he’s just like anyone else (quiet down, back there). Rationally, this guy will keep polluting as long as the benefit to him of doing so is at least P. Now let’s suppose there are 6 billion people (including this Gelbach character). Since each of those people bears the same pollution cost as Gelbach does when he pollutes, the total costs of one more pound of Gelbach’s carbon emission is 6,000,000,000 x P. 

Under the reasonable assumption that others on the globe don’t benefit from the activity that yielded Gelbach’s carbon emissions, the problem is now clear: the last (or "marginal", as we economists call it) pound of carbon that Gelbach emits has a private benefit to Gelbach of P--and an equal private marginal cost. But its social--i.e., aggregate--cost is 6,000,000 x P. Since there’s nothing special about Gelbach (I said quiet), everyone’s behavior will have the same externality problem. And thus we get too much pollution--a level such that the value of the economic benefits that we realize by polluting are outweighed by the value of the environmental costs. (There is nothing touchy-feely about this analysis; you might even fail your comps at a top PhD program in econ unless you can prove it with calculus.)

(If you want a different example, just think about what happens when you go out to dinner with 9 friends and everyone agrees--ahead of time--to split the bill 10 ways. That filet mignon and glass of Macallan 18-year suddenly seem a lot cheaper when you have to pay only 1/10th of its cost. Unfortunately, everyone’s filet costs her just 1/10th; ditto the Macallan. If you’re anything like me and my friends, you spend more per head when you go out in a group and split the bill.)

Do offsets like those sold by TerraPass make a difference? Well, they can, insofar as Easterbrook’s economies-of-scale point is true. The key thing is to observe that they do so by reducing the individual, private costs of reducing emissions, rather than by forcing individuals to internalize the costs of their polluting behavior. That is, offsets allow altruistically, environmentally minded people to cheaply maintain a given level of what we might call a "carbon-generated standard of living".

But notice that offsets don’t do anything to force people to internalize the costs of their behavior. Suppose the world is composed of two types of people--Easterbrooks and Inhofes. Easterbrooks want to reduce pollution and are willing to tow their own weight in so doing: they buy offsets sufficient to reduce their net footprints to the point where the external effects of their behavior is 0. Our mythical (perhaps I should say hoaxical) Inhofes, on the other hand, are certain that there is no human role in climate change. Since they are just as rational as old Gelbach, they refuse to pay something for (what they think is) nothing, so they buy no carbon offsets. Well, bully for the Easterbrooks--they still face the external costs caused by the Inhofes of the world, even though they’ve paid enough to spare the Inhofes from Easterbrookian pollution.

So, are offsets smart economics? Yes, in that they reduce the costs of responsible behavior for those who are altruistic enough to bear these costs voluntarily. But--resoundingly--No, in that they do nothing to align the social and private costs of others’ behavior.

Easterbrook comes up with a nice hybrid (pardon the pun) idea, though. Suppose we capped or taxed carbon emissions but allowed equal credit for offset purchases. This policy would allow people to escape their carbon tax bill if they could find a company that would do emissions-reduction for them. That sort of policy induces people and companies to find ways that are cheaper than the tax to reduce emissions. As a result, it’s a policy that not only will reduce emissions, but also will promote investment in better future technologies that will lower the cost of pollution reduction. Easterbrook also points out that marginal pollution-reduction dollars are probably better spent in China than in the US at the moment, given the staggering growth in China’s economy and pollution.

Easterbrook’s overlooking of the externality problem aside, these are all good points. People should take them seriously in thinking about policy responses to the threat and reality of global climate change.

As my examples above suggest, markets are part of the problem when they generate uncorrected external costs. But when they’re used together with well-designed policies, markets can also be part of the solution.

(I may have more to say about externalities, policies to address them, and cost-benefit measures sometime soon.)

Posted by Jonah Gelbach on March 10, 2007 at 03:35 PM in Current Affairs | Permalink

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Comments

This is classic Easterbrook: he must have a contractual provision to make one major error which he premises a huge part of the article on and to attack one major Democrat in every article. (I defy you to find an article he's written in the last 20 years in which this is not true.)

Posted by: Bart Motes | Mar 12, 2007 11:32:19 AM

Al Gore has provided an excellent solution, carbon taxes, and he has been much more courageous than most politicians. In a July 19, 2006 speech at Wal-Mart’s Bentonville, AR headquarters, Gore said, "We should sharply reduce payroll taxes and make it all up in CO2 taxes so the low- and middle-income people don’t bear the cost burden of this big transition in energy sources." Gore spoke in the same vein two months later at NYU Law School:

"For the last fourteen years, I have advocated the elimination of all payroll taxes — including those for social security and unemployment compensation — and the replacement of that revenue in the form of pollution taxes — principally on CO2. The overall level of taxation would remain exactly the same. It would be, in other words, a revenue neutral tax swap. But, instead of discouraging businesses from hiring more employees, it would discourage business from producing more pollution."

For more information on carbon taxes, see www.carbontax.org.

Posted by: Dan | Mar 11, 2007 8:24:12 PM

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Posted by: goblin | Mar 11, 2007 1:53:05 PM

"That filet mignon and glass of Macallan 18-year suddenly seem a lot cheaper when you have to pay only 1/10th of its cost. Unfortunately, everyone’s filet costs her just 1/10th; ditto the Macallan. If you’re anything like me and my friends, you spend more per head when you go out in a group and split the bill"

I've seen friendships ruined over this, and a long-running academic spat spawned by an $80 bottle of wine at a conference. All I can say is, a calculator is a beautiful thing.

Somehow the Al Gore electric bill does not surprise me. The movie showed him driving around from talk to talk, using fossil fuels with gusto and abandon. The movie was especially weak on solutions, which is where, I think, the heart of the problem is. More people would do things to correct the problem if they knew how or what to do... so Al Gore could have talked about carbon footprint payments in the movie, but he didn't. Sigh.

Posted by: Miriam Cherry | Mar 11, 2007 4:21:30 AM

Cabon off-sets may well be boondoggel for all I know but I'd certainly be hesitant to trust _anything_ that Greg Easterbrook says about anything even remotely relating to science since he's shown himself to be a pretty large fool in that area over and over again.

Posted by: Matt | Mar 10, 2007 11:53:32 PM

Encourage people to see the video "The Great Global Warming Swindle".

Here is an easy URL to remember to see the program. Pass it along to friends and family.

http://gorelied.notlong.com

Posted by: Sean | Mar 10, 2007 10:15:27 PM

Forestpolicy quotes report at carbonwatch:Carbon offsets are the modern day indulgences, sold to an increasingly carbon conscious public to absolve their climate sins. Scratch the surface, however, and a disturbing picture emerges, where creative accountancy and elaborate shell games cover up the impossibility of verifying genuine climate change benefits, and where communities in the South often have little choice as offset projects are inflicted on them.

Even the ever-optimistic MIT Tech Review a few months back posted a skeptical report; they noted there seems to be no limit to the quantity of offsets issued.

Posted by: chris miller | Mar 10, 2007 10:11:18 PM

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